ECB to hold rates again but keep door ajar to further easing

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) -The European Central Bank is set to leave interest rates unchanged on Thursday as inflation remains in line with its target, but a fraught trade and political outlook means it will keep alive the prospect of further easing.

The ECB halved its key rate to 2% in the year to June but has been on hold ever since, arguing that the 20-country euro zone economy is in a "good place", even if more easing cannot be ruled out.

Data over the summer has only confirmed this sanguine view, giving policymakers time to understand how U.S. tariffs, higher German government spending and political turmoil in France might impact growth and inflation.

This makes it likely that ECB President Christine Lagarde will once again aim to be "deliberately uninformative" about the future path of interest rates - as in July, when she batted back every question on the way forward.

But Lagarde is unlikely to close the door on further rate cuts, especially since inflation is projected to dip below the ECB's 2% target next year, keeping alive market bets that a final "insurance" cut could come around the turn of the year.

"While officially the Governing Council sees inflation risks as broadly balanced over the medium term, most members probably still regard downside risks as somewhat more prominent," UniCredit analysts said in a note.

"The ECB will probably leave the door open for a further rate reduction if downside risks were to intensify."

In any case, the debate is at the margins and focuses on just a single rate cut, indicating that the ECB is done with the bulk of changes to monetary policy and rates are likely to stay around this level for an extended period.

The ECB will announce its decision at 1215 GMT, followed by Lagarde's 1245 GMT news conference.

RISKS

The key debate will be around how policymakers see risks.

Hawkish Governing Council members, who are opposed to further easing, say the euro zone economy has been unexpectedly resilient to trade tensions and that growth is well supported by buoyant private consumption.

They point to rebounding industrial production and a surge in German government spending to argue that growth will remain on a moderately upward path.

Although U.S. President Donald Trump's 15% tariffs on European Union imports are higher than predicted, firms are showing adaptability and the certainty of having agreed a deal offsets some of the negatives.

"We think the ECB's easing cycle has ended," UBS economist Reinhard Cluse said. "We think the ECB will not cut rates further in light of the sizeable fiscal stimulus targeting defence and infrastructure, which is likely to be increasingly visible from early 2026."

But policy doves say that tariffs have yet to fully work their way through the economy and could dampen an already low growth rate, reversing the rise in consumption.

This could then weigh on prices next year, just when inflation is seen dipping below target, raising the risk that firms will change their pricing and wage-setting, thus entrenching anaemic price growth, much like before the pandemic.

The U.S. Federal Reserve's looming rate cuts are meanwhile likely to help the euro firm against the dollar, putting downward pressure on prices.

"What we have seen since June, to us, will reinforce disinflationary forces," Bank of America said. "An economy with a negative output gap, below-trend growth, and an inflation undershoot that is about to start and will likely become persistent, calls for some stimulus."

A fresh bout of political chaos in Paris, which has pushed French bond yields sharply higher, is another headache for the euro zone's central bank.

It has tools to intervene, but only for an "unwarranted and disorderly" rise in borrowing costs, which economists say is clearly not the case now, given France's high debt and feeble economic growth.

(Writing by Balazs Koranyi; Editing by Catherine Evans)